If I am not mistaken, Guillermo Sanchez already acknowledges that Sraffa’s critique of Hayek on the non-existence of the Wicksellian natural rate of interest is sound.

Sanchez states:

“Robert P. Murphy’s great paper “Multiple Interest Rates and Austrian Business Cycle Theory” (2010) takes the subject directly as Lachmann did. The enormous merit of this paper is that even if Sraffa was right, his critique does not refute ABCT. In other words he was able (after criticizes Lachmann’s solution) to ensure the validity of ABCT in Sraffa’s own terms (a multiple rates environment). ABCT is still valid even in the circumstances in which Sraffa said it would not be valid. He managed to do it using a Dynamic Equilibrium simple model. Maybe the best refutation is not to demonstrate that Sraffa was wrong, but to demonstrate that even if he was right, the theory still holds logically”

What Sanchez is trying to argue here is that ABCT can be reformulated by purging it of its use of the natural rate of interest, and that such a reformulated ABCT can be defended against Sraffa’s critique on the basis of the mythical natural rate.

That is perfectly true, of course, and I have never denied this. The problem is that such a theory is not a Hayekian theory, it requires real world tendency to a general equilibrium state, and it is still subject to a host of other problems, such as subjective expectations, uncertainty, capital theory, unrealistic assumptions about use of resources, and so on.

But let me turn to the specific criticisms Sanchez has of my arguments:

(1) First, Sanchez points out a red herring:

“Lord Keynes” does not mention the fact that Mises was not the only one whose theory relied on the [W]icksellian natural interest rate concept. Keynes himself confessed that he also relied on it on the same time (early 30s) that Sraffa accused Hayek of using that unique rate concept …. As everybody knows, in the early 30s (and before that) Keynes was a [W]icksellian and a quantitative [= “quantity” – LK] theorist.

Yes, before the General Theory Keynes was indeed a quantity theorist and used the natural rate. But so what? Keynes was wrong.

Let me repeat that: Keynes was as wrong and misguided as any neoclassical in these years in his use of these concepts.

But, in the end, Keynes abandoned the natural rate idea between the Treatise on Money and his writing of the General Theory. Keynes came to see that the “natural rate” does not equate investment with savings, that savings can be much higher than investment, and that subjective expectations can shatter business confidence.

(2) Next, Sanchez asks me this:

“Why did ‘Lord Keynes’ accuse Mises (or Hayek) of using Wicksell’s natural rate and did not say anything about Keynes who was using it too two years after Mises and at the same time that Sraffa was accusing Hayek of using that [W]icksellian concept? Has he the guts to refute his ‘master’’s Treatise and his previous books because he was using the [W]icksellian natural rate concept? Can LK write ‘Keynes’s early theory is a complete nonsense because he relied on [W]icksellian theory of natural rate of interest’ or ‘All Keynes’s pre-GT writings on monetary and interest theory are worthless because he relied on [W]icksellian natural rate’? I doubt it. But let’s assume LK admits it and says “yes, all what Keynes wrote before GT is garbage because he relied on Wicksell natural rate. But obviously later on he did not used that faulty concept.”, however he himself has confessed that Mises in his later treatments abandoned that concept too. So in order to be intellectually honest he must say that Mises-ABCT is as immune to Sraffa’s criticism as it is the monetary and interest theory of Keynes in GT.”

The answer is “yes.” A great deal of what Keynes wrote before the General Theory is wrong, because of his use of neoclassical theory. (Although not all of it is wrong, for Keynes was, for example, receptive to the Chartalist theory of money and wrote some quite insightful though things about the history and nature of money).

In fact, I am surprised that any knowledgeable Austrian really thinks he has scored any points here. And, as I have admitted above, yes, a version of the ABCT purged of the Wicksellian natural rate of interest can be defended against Sraffa.

(3) The third issue is that Mises’s originary interest rate is still a flawed, real theory of interest. Interest is a monetary phenomenon, not explained by time preference.

If Mises’s originary interest rate is false, it follows that his later version of the ABCT (without the natural rate) still has a severe flaw.

(4) The objection that an economy where factor inputs are relatively abundant still poses a serious problem to the Austrian business cycle theory, despite what Sanchez says.

Instead of dealing with this issue, he merely distorts the issue, by attributing a straw man to his opponents. Keynesians and even Marxists do not deny that insufficient resources are often a problem in the real world.

The word “scarce” can have two meanings: (1) finite, and (2) insufficient quantities available in relation to demand. When I say that something is “relatively abundant,” I mean that it is available in a quantity that exceeds the demand for it.

But relative scarcity and relative abundance in these senses exist, and an economy can have a relative abundance of certain goods in any time outside a boom. International trade also provides goods even when domestically there might be shortages.

Nor do I deny that as an economy expands and reaches a boom, inflationary pressures build up as resources become less available.

Critics of my posts on the ABCT have simply misunderstood my critique. The non-existence of the natural rate of interest is one of the reasons why Hayek’s early business cycle theory is wrong. That critique applies to all Hayekian forms of the theory that use the natural rate, and even these Austrian critics are admitting this point.

The other versions of ABCT are flawed for other reasons. One of these is the unrealistic assumption of a economy that converges to a general equilibrium state:

Thursday, January 24, 2013

I have updated my earlier set of links to various posts on my blog for debunking the theories of Austrian economics.

I will repeat the introduction to these links as well.

Please note that not all the posts actually debunk Austrian theories, as some are merely descriptive, and allow the reader to understand what the Austrians believe. Some posts examine the history of the school. A few posts are even constructive in that Post Keynesians and some Austrians can agree on certain points (such as the posts on Ludwig Lachmann).

One important point I have always stressed is that the Austrian school itself is heterogeneous.

In my view, a useful division of modern Austrians would be as follows:

Some of the first generation Austrians were actually progressive liberals and sympathetic to Fabian socialism. Hayek came to support public works and fiscal policy in a depression. Ludwig Lachmann accepted government intervention for economic stability in depressions, and rejected even the idea that free markets tend to general equilibrium.

(9) Against the Austrian View of Deflation
Some Austrians think deflation is desirable; others do not. Hayek most notably changed his mind and condemned “secondary deflation.” The Austrians hold inconsistent views on deflation.

(27) Debunking Austrian Ethical Theories
There are at least two positions taken by Austrians on ethics: (1) some (like Mises) support a kind of utilitarianism/consequentialism, and (2) others support natural rights (Rothbard) or argumentation ethics (Hoppe).

Austrian’s hyperinflation lasted from October 1921 to September 1922. Curiously, the annual figures show no real output decline in either 1921 or 1922, but there was a real GDP loss of 0.99% in 1923. I assume that this was in some way the consequence of the hyperinflation.

By contrast, in Austria’s deflationary depression from 1929 to 1933, real output fell by 22.45%. The output loss under the hyperinflation looks very mild by comparison.

II. Germany
Again, real GDP data is below with data extending to the Great Depression:

Germany’s real output loss was 16.91% in 1923, a very severe loss, and in one year. Curiously, the real output loss from 1929 to 1932 was 16.11%, slightly lower, but extended over four years of depression.

Why was there such a gulf between Germany and Austria in terms of real output loss during their hyperinflations?

Possibly, the reason was that the Austrian inflation rates were lower. However, with an inflation rate of 1426% in 1922 in Austria, it still seems surprising that the GDP fall was only 0.99%.

(1) Japan’s real GDP fell by 50% in 1945, one of the most disastrous falls ever seen in any nation.

(2) From 1946 to 1973, Japan’s annual real GDP figures show no decline: it did not see any fall in annual figures in this period (Sorkin 1997: 569). Instead of a business cycle, there was what can be called a growth cycle (phases of slower or faster growth) (Sorkin 1997: 569). This in my view has much to do with Japan’s highly successful industrial policy, conducted in these years by the government department called the “Ministry of International Trade and Industry” (MITI; or, in Japanese, 通商産業省 [Tsūshō-sangyō-shō]), although both the Japanese Ministry of Finance and the Economic Planning Agency were also involved.

For a seminal account of MITI, see Johnson (1982).

Critics of the notion that the success of Japanese industrial development was due to MITI occasionally point to some mistakes the organisation made, as if this refutes the overall success of the policies it implemented.

But the Japanese government had already adopted a vigorous industrial policy from Meiji era onwards that launched Japan on its road to economic greatness. I have dealt with that in this post.

To a great extent, the role of MITI after 1945 was merely a continuation of the government intervention in the economy that had always characterised Japan.

The extent of the economic industrial planning in Japan has always puzzled Western observers – especially economists – and a well known joke arise reflecting this: Japan was supposedly “the only Communist country that works” (a remark apparently made by an Italian journalist in Japan in 1989: House 1989). (On this issue, it is striking that Marxism had a not inconsiderable influence on academic economics in Japan in the post-1945 era: as late as the 1960s, the economics department at Tokyo University, the most respected in Japan, was heavily Marxist [Hadley 1989: 292].)

Japan, like Germany, had a curious post-WWII boom, not only from reconstruction of the devastated economy, but also through strong industrial development. By 1965, the post-WWII recovery and boom had run its course, and Japan required more fiscal stimulus and greater social spending. That was provided by the government in a program of deficit-financed stimulus that actually continued for many years, and – apart from the oil shock years – did not result in serious inflation (Hadley 1989: 306–307). Real GDP growth – as can be seen from the figures above was – was also impressive.

In 1979, the deficit reached 6.1% of GDP and stimulus averted an actual recession in Japan in these years when other nations were plunged into the global recession that radiated out from the US in the wake of the Volcker shock.

(4) In the 1980s, Japan engaged in ill-conceived financial deregulation (Fukao 2003: 134–135), which was one major cause of the asset bubble in these years (although poorly designed tax policies and monetary policy were clearly involved too). The collapse of the asset bubble and the balance sheet recession (a form of debt deflationary crisis) caused the “lost decade.”

From the data above, we can see that the “lost decade” was really an era of low growth, not continuous negative growth. Japan was not in recession from 1993–1997, but had serious deleveraging problems, a banking crisis, and debt deflation.

Many myths have arisen about the lost decade, and one of them is that Keynesianism somehow “failed” to work in this era. That is nonsense. If anything, Keynesianism saved Japan from a terrible depression. In fact, when fiscal stimulus was abandoned for austerity in 1997, the economy plunged into a recession in 1998.

Japan had mild to moderate Keynesian stimulus packages from about 1993 to 1997 (although the actual fiscal impact of some of the early ones is grossly exaggerated [Posen 1998: 41]), but the result was mild to moderate growth from 1993–1995. In 1996, expansionary policy produced an impressive 3.49% growth rate – much higher than anyone predicted (Posen 1998: 41). (As an aside, I highly recommend Adam S. Posen’s Restoring Japan’s Economic Growth [Washington, D.C. 1998], p. 41f. for analysis of the extent of fiscal stimulus in the 1990s.)

But then from 1997 Prime Minister Ryutaro Hashimoto imposed sharp fiscal contraction and a recession resulted.

A major consequence of the recession induced by fiscal contraction was that the Japanese budget deficit soared by 68% as tax revenue collapsed. This must be counted as one fundamental reason why Japanese public debt soared so badly. When fiscal expansion was applied again on a large enough scale in 1998 the recession ended and growth resumed.

All this is well known in the Japanese press:

“Japan’s first experiment in austerity policies began under Prime Minister Ryutaro Hashimoto (1996–98). Severe spending cuts were seen as needed to rein in budget deficits caused by previous efforts to recover from the 1991 Bubble collapse. Recession followed quickly. Tax revenues collapsed. The national debt increased.

Under Prime Ministers Keizo Obuchi (1998–2000) and then Yoshiro Mori (2000–2001), Japan returned to fiscal expansion policies and the economy recovered rapidly, with the Nikkei Dow share index reaching almost 20,000. But with tax revenues still only in the recovery stage the deficit hawks were able to swoop in once again under Prime Minister Junichiro Koizumi (2001-2006). Austerity in the name of ‘structural reform’ became the order of the day. The Nikkei Dow promptly collapsed to the 7,000 level, tax revenues fell again and the national debt increased by ¥200 trillion in just five years despite the boost to the economy from expanded exports to China and the United States.”

Japan in the 1990s was somewhat like America in the 1930s: although Japan differed from the US in that averted an actual depression, its fiscal policy was not applied properly and was then reversed in 1997 a disastrous error. In the US, Roosevelt reversed his moderate fiscal expansion in 1937, and the US relapsed into depression in 1938. Both 1938 (in the US) and 1998 (in Japan) serve as warnings of the dangers of austerity in a weak economy.

It is a pity that the lesson of the Japanese lost decade is forgotten, completely misunderstood or utterly misrepresented by certain neoclassicals, Austrians and other advocates of austerity.

Hadley, E. M. 1989. “The Diffusion of Keynesian Ideas in Japan,” in Peter Hall (ed.), The Political Power of Economic Ideas: Keynesianism Across Nations. Princeton University Press, Princeton. 291–309.

House, Karen Elliott. 1989. “The Second Century – World Leadership – The ’90s and Beyond: Though Rich, Japan is Poor in Many Elements Of Global Leadership – In Politics, Arms and Ideology, It Wields Little Influence, While Alienating Many – Myth of an Asian Trading Bloc,” Wall Street Journal, 30 January: 1.

Johnson, Chalmers. 1982. MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925–1975. Stanford University Press, Stanford, Calif.

Lachmann discusses Menger’s attitude to “economic laws” and the law of demand:

“For a long time students of Menger have been puzzled by the precise meaning of his notion of ‘exact laws’. He regards it as the prime task of economic science to formulate such laws. In Appendix V of the Untersuchungen we are told that ‘in the field of human phenomena exact laws (so-called ‘laws of nature’) are attainable under the same conditions as in that of natural phenomena.’ In this regard, then, there is no difference at all between social and natural sciences. On the other hand, Menger distinguishes sharply between these ‘exact laws’, i.e. ‘laws of the phenomena which are not only valid without exception but which, according to the laws of our thought simply cannot be thought of in any other way but as without exceptions’ (Menger 1963: 42), and ‘empirical laws’ which rest on observation and admit of exceptions.

Menger uses the ‘law of demand’ as an example for this distinction. According to him the exact law tells us not merely that a rise in demand will lead to a rise in price, but that, under certain conditions, the extent of this price rise is quantitatively exactly determinable (‘dem Masse nach genau bestimmbar’). But he goes on to warn us that these conditions require not only that all participants maximize their satisfaction in the pursuit of which they must be free of all external coercion, but also the absence of error and ignorance. Hence we must not expect to find instances of the exact law in the real world. It is [sc. according to Menger – LK]

unempirical when tested by reality in its full complexity.

But what else does this prove than that the results of exact research do not find their criteria in experience in the above sense? The above law is, in spite of everything, true, completely true, and of the highest significance for the theoretical understanding of price phenomena as soon as one looks at it from that standpoint appropriate for exact research. If one looks at it from the point of view of realistic research, to be sure, one arrives at contradictions … but in this case the error lies not in the law, but in the false perspective. (Menger 1963: 57).

These views will no doubt strike many of us as odd, but the main reason for it is that we have come to take it for granted that ours is a world of relentless positivism. There will be few natural scientists today ready to acknowledge that their prime task is to find exact laws of the kind Menger describes. For the most of us ‘laws of nature’ are empirical laws, in principle falsifiable.” (Lachmann 1994: 209–210).Menger’s views on the law of demand are quite peculiar. On the one hand, the law of demand is “unempirical when tested by reality in its full complexity,” but at the same time, “in spite of everything, true, completely true”!

That Menger could seriously believe and write those words demonstrates that he formulated the law of demand at a level so abstract that it could only be true in that almost imaginary world. It is as if we were to formulate a law that must be necessarily true in the Land of Oz, admit that such a law is not universally true in our world, but nevertheless contend that such a law is always and universally true in Oz, the world of our imagination.

That all this bespeaks a deeply flawed, even deluded, approach to the social sciences goes without saying.

Menger conceded that when related to the empirical real world of experience, the law of demand” arrives at contradictions.” That is quite clearly a continuing problem with the law of demand even in neoclassical economics.

Thursday, January 17, 2013

The late Mark Blaug (1927–2011) puts his finger on a crucial point about the law of demand:

“It was Marshall who first drew attention to the fact that the so-called universal law of demand is unfortunately subject to a possible exception, namely, Giffen’s paradox, the case where, to express it in modern language, the negative-income effect of a price change is so large in absolute terms as to cancel out the negative substitution effect of that change. The fact that Sir Robert Giffen never actually stated Giffen’s paradox … is of considerable significance: Marshall was looking, as it were, for Giffen’s paradox and, therefore, was determined to find it. He realized that for practical purposes, we must define individual demand curves as subject to a ceteris paribus clause that includes tastes, expectations about future prices, the money incomes of consumers, and all prices other than the one under consideration. So defined, however, it was not possible to argue that there is in fact one ‘universal’ law of demand.

Marshall also flirted, as Friedman has shown (see Blaug, 1980, pp. 351–3, 369), with a constant-real-income interpretation of demand curves in which the prices of all closely related goods are varied inversely to the price of the good in question (in practical terms, we divide money income by a Laspeyres price index) so as to ‘compensate’ the consumer for any change in real income caused by the price change. Such a constant-real-income or compensated demand curve must indeed be negatively inclined under the very conditions implied in its construction, and hence, Friedman argued, we ought to choose this interpretation as the more preferable one because it alone has an unambiguously testable implication. Alas, a compensated demand curve is never observed, whereas we do at least observe one point on the constant-money-income demand curve. The constant-real-income formulation of demand curves is thus an evasion of issues: the income effect of a price change is as integral a part of real-world consumer behavior as is the substitution effect and to leave it out is to adjust the world to fit our theories rather than the other way round. (Blaug 1996: 140–141).

I hope readers can see the significance of this passage.

There is indeed some confusion about the law of demand: does it require, in its ceteris paribus assumption, that (1) only money income remain constant, or (2) does it assume that real income must remain constant?

Some formulations of the law of demand seem to require that real income must remain constant.

But how is this an even remotely realistic assumption? All price changes must change real income, and it is not possible for a price change to occur in the real world without changing real income. We have a law that is formulated in a way that is grossly unrealistic, if not logically incoherent.

Of course, if one wants to define the ceteris paribus assumption as only referring to money income and not real income, we have a different law.

So advocates of the law of demand must define carefully what they mean by the ceteris paribus qualification.

Tuesday, January 15, 2013

First, what do “economic laws” even mean? Economic “laws” are certainly not like laws of nature. No person can simply jump into the air (unaided by technology) and violate the law of gravitation. Yet it is possible in both theory and practice for people to violate the law of demand.

If this were not so, then how do speculative bubbles ever emerge and develop in economies? If the price of houses is rising sharply, the law of demand tells us that demand should fall. People will substitute some other good for expensive houses. But that is not what happens during speculative bubbles: the demand for houses increases, and increases sharply, even as prices soar. In fact, the rising prices are clearly a causal factor in the increased demand, because the increase in value, and the desire make money, is what attracts people.

Already we see that the “law of demand” has little or no explanatory power with respect to the prices of, and demand for, durable goods or assets bought and sold on markets where there are vast secondary stocks (consisting of “used” or “second hand” goods) of such goods/assets, in addition to the newly produced versions of the same good/asset.

Secondly, the expression “economic law” is misleading. Most economic laws – as in “laws” in the social sciences generally – are observed regularities in phenomena and human behaviour. But “regularities” are not necessarily universal. This is perfectly clear in social relations. It is an observed regularity that parents look after their biological children in human societies. One might even describe this as a type of “social law” of human society. But everyone knows there are exceptions: grossly negligent, irresponsible or immoral parents who do not care properly for their offspring. Some parents may even abandon their children or put them up for adoption. The “social law” is not like a hard law of nature at all. It is an empirical observation, and a human behaviour that has both biological/genetic and environmental/cultural causes, which there can be exceptions to.

I doubt whether most “economic laws” are much different from “social laws.” Although one might be able to point to a core of economic laws that are truisms – e.g., you can’t have consumption without prior production – these are usually trivially true propositions that do not take us very far.

Since economic behaviour is governed not only by human impulses, nature and psychological traits (caused by “nature,” as it were), but also by institutions, culture and social structures (environmental or general cultural factors), we should not expect absolute universality of all currently observed economic “regularities” in the past or in societies with different institutions and cultural practices (but note that I am most decidedly not endorsing fashionable postmodernism or cultural relativism by these remarks). No doubt there are some “regularities” that do hold true in almost all human societies in all times, but there is no a priori reason to expect all such “economic laws” do, even in a modern society.

So what about the law of demand? Certainly there must be many commodity markets where prices and demand do indeed behave like supply and demand curves: that is, demand will rise as the price falls (Keen 2011: 72–73). But it is likely that there are a significant number of markets where the law of demand does not apply.

Anyone who has done even an undergraduate degree in economics knows that the law of demand cannot really be universal, e.g., the possibility of Giffen goods already invalidates its claim to universality.

In fact, we can draw attention to these exceptions to the law of demand already well known in economics textbooks:

(1) Giffen goods/inferior goods

(2) Veblen goods/”snob” goods

(3) goods/assets on speculative markets

(4) psychological bias relating to relationship between price and quality
Some consumers evaluate the quality of a good from its price. That means that some consumers could in theory prefer higher priced goods to lower priced goods and shun cheaper goods under the impression that cheaper goods are inferior (even when they are not).

(5) Demand during times of scarcity or fear of scarcity
Fear of expectation of shortages or scarcity during abnormal times (disaster or war) can cause people to buy more of a good even as their price rises, to stock up in the expectation of insufficient supply in the future.

(6) Necessities
The basic staples of everyday life often have a stable demand even when prices rise.

But even more radical criticisms of the law of demand can be made.

One can see a good critique of the law of demand in Keen (2011), but I will leave this for another post.

On pp. 17–18, Hansen assumes a hypothetical model of postwar US GDP in which both private consumption and investment spending would rise considerably from 1943.

Hansen makes it clear that he regarded this as the most probable outcome for the US economy after the war:

“Altogether the various factors enumerated above indicate the great possibilities for the expansion both of consumption and of private investment during the transitional period. Indeed, the potentialities for expansion of consumption and private investment in the immediate postwar period are sufficient to indicate the possibility of a genuine and fairly prolonged postwar boom. The Federal government should, however, be prepared to play a balancing role, checking any temporary tendency toward an excessive boom, and, on the other hand, be prepared to go forward with large Federal expenditures on public improvement projects to compensate for any strong tendency toward deflation and depression.” (Hansen 1943: 18).

So, while Hansen did hedge his bets, in the sense that he thought that any tendency towards “deflation and depression” would require fiscal stimulus, nonetheless he felt there were “great possibilities [my emphasis] for the expansion both of consumption and of private investment during the transitional period. Indeed, the potentialities for expansion of consumption and private investment in the immediate postwar period are sufficient to indicate the possibility of a genuine and fairly prolonged postwar boom.”

Elsewhere, Hansen also made it clear that he was an optimist, and did not share the views of the pessimists about the post-war economy:

“The fact is that many people dread to think of what is coming. Businessmen, wage earners, white-collar employees, professional people, farmers—all alike expect and fear a postwar collapse: demobilization of armies, shutdowns in defense industries, unemployment, deflation, bankruptcy, hard times. Some are hoping for a postwar boom. We got that after the First World War. Not improbably we may get it again. If the war lasts several years, we may have at the end of the war sufficient accumulated shortages in residential housing, in durable consumers' good such as automobiles, and in the plant and equipment required to supply peacetime consumption demands, to give us a vigorous private investment boom. Indeed, we need to be on the alert to prevent a possible postwar inflation. If in fact we do experience a strong postwar boom, there is, however, the gravest danger that it will lull us to sleep. Sooner or later such a boom will end in a depression unless we are prepared. If appropriate action is taken, there is no necessity for a postwar collapse.

Everywhere one hears it said that, when this war is over, all countries including our own will be impoverished. This view is, however, not sustained by past experience. No country need be impoverished if its productive resources (both capital and human) are intact. The productive resources of this country will be on a considerably higher plane when this war is over than ever before. A larger proportion of our population will be trained to perform skilled and semiskilled jobs. We shall have enormous productive capacities in all the machine industries. And in special consumers’ durable industries where plant and equipment may have become deficient by reason of the war, we shall be able very quickly, with our large basic machine-producing industries, to expand to meet the peacetime requirements. We shall have, when the war is over, the technical equipment, the trained and efficient labor, and the natural resources required to produce a substantially higher real income for civilian needs than any ever achieved before in our history.” (Hansen 1943: 12–13).

What emerges from this is that opinion on what would happen after the war was divided. There was indeed some pessimism about the possibility of a severe slump after 1945 amongst certain “[b]usinessmen, wage earners, white-collar employees, professional people, [and] farmers.” It was not some opinion held merely by Keynesian economists (and even amongst Keynesians there were important optimists). In the end, Hansen did not share the pessimistic view, and explicitly stated that he thought the idea was not “sustained by past experience.”

Moreover, there was nothing inherently unreasonable about the idea that America might face severe unemployment problems and depression after the war. Business expectations are subjective. They can change rapidly in response to shocks. What happened to the private US economy after 1945 was dependent on expectations. Either a boom or slump was possible. The fact that some Keynesian economists did think a slump was coming does nothing to invalidate their underlying macroeconomic theory, for Keynesian economics (or at least that of Keynes himself and those heterodox varieties not compromised by neoclassical economics) stresses the uncertainty of the future. It is not possible to predict with certainty or with objective probability scores the state of certain future economic variables in market economies. All one can do is make forecasts qualified by assumptions about how expectations will play out. One’s assumptions may turn out to be right or wrong.

As it happens, Keynes, Hansen and Richard M. Bissell were right in their forecasts about the post-1945 US economy.

This question is closely related to the reasons why there were no serious economic problems after 1945 that some economists and the general public expected.

Of course, the boom in private investment after 1945 employed many men. But that is by no means the only reason.

Before 1945, about 14 million men served in the US armed forces, but by summer 1946 that number had been reduced to just over 2 million, although this decreased further in the course of the 1940s (Adams 1967: 161).

So, first, it can be seen that the creation of a standing army employed some 2 million men.

What about the other 12 million? Were they all just suddenly dropped into the labour market? The answer is no.

What happened is that – because of the G.I. Bill – many G.I.s undertook education and training programs after 1945 and did not seek full-time employment:

“While World War II was still being fought, the Department of Labor estimated that, after the war, 15 million men and women who had been serving in the armed services would be unemployed. To reduce the possibility of postwar depression brought on by widespread unemployment, the National Resources Planning Board, a White House agency, studied postwar manpower needs as early as 1942 and in June 1943 recommended a series of programs for education and training. The American Legion designed the main features of what became the Serviceman’s Readjustment Act and pushed it through Congress. The bill unanimously passed both chambers of Congress in the spring of 1944. President Franklin D. Roosevelt signed it into law on June 22, 1944, just days after the D-day invasion of Normandy.

American Legion publicist Jack Cejnar called it ‘the GI Bill of Rights,’ as it offered Federal aid to help veterans adjust to civilian life in the areas of hospitalization, purchase of homes and businesses, and especially, education. This act provided tuition, subsistence, books and supplies, equipment, and counseling services for veterans to continue their education in school or college. Within the following 7 years, approximately 8 million veterans received educational benefits. Under the act, approximately 2,300,000 attended colleges and universities, 3,500,000 received school training, and 3,400,000 received on-the-job training. The number of degrees awarded by U.S. colleges and universities more than doubled between 1940 and 1950, and the percentage of Americans with bachelor degrees, or advanced degrees, rose from 4.6 percent in 1945 to 25 percent a half-century later.”
http://www.ourdocuments.gov/doc.php?flash=true&doc=76

So nearly 6 million returned G.I.s, in the 7 years following the passing of the G.I. Bill, received education in colleges, universities or schools, and this prevented a major supply shock in the labour market. And that means nearly half of returned servicemen (of course, it also inaugurated the era of mass, higher education).

Instead of some 12 million men looking for work, the figure was reduced to about 6 million, and the investment boom after 1945 was capable of absorbing this level of labour. But would the private economy after 1945 have been able to employ some 12 million men? I doubt it. I suspect there would have been an unemployment problem in the absence of the G.I. Bill.

Furthermore, the welfare provisions of the G.I. Bill had a significant effect on economic activity, not only in terms of placing a floor on the income of returned men, but also by maintaining demand for goods and services while they were undertaking education programs.

BIBLIOGRAPHY

Adams, D. K. 1967. America in the Twentieth Century: A Study of the United States Since 1917. Cambridge U.P, London.

Friday, January 4, 2013

I suspect most readers know who Alvin A. Hansen was. For those who do not, Alvin Hansen was a major US Keynesian economist (albeit of the neoclassical synthesis variety), and some even referred to him as the “American Keynes” for his role in introducing Keynes’s economic ideas to the United States after 1936.

“The fact is that many people dread to think of what is coming. Businessmen, wage earners, white-collar employees, professional people, farmers—all alike expect and fear a postwar collapse: demobilization of armies, shutdowns in defense industries, unemployment, deflation, bankruptcy, hard times. Some are hoping for a postwar boom. We got that after the First World War. Not improbably we may get it again. If the war lasts several years, we may have at the end of the war sufficient accumulated shortages in residential housing, in durable consumers’ good such as automobiles, and in the plant and equipment required to supply peacetime consumption demands, to give us a vigorous private investment boom. Indeed, we need to be on the alert to prevent a possible postwar inflation. If in fact we do experience a strong postwar boom, there is, however, the gravest danger that it will lull us to sleep. Sooner or later such a boom will end in a depression unless we are prepared. If appropriate action is taken, there is no necessity for a postwar collapse.” (Hansen 1943: 12–13).

I concede that Hansen’s prediction was a cautious one (“Not improbably we may get it again”). But it was an important prediction nonetheless.

Hansen correctly foresaw that a surge in private investment and consumption owing to the release of demand pent up during the war would drive the post-1945 economy.

He also correctly foresaw that this boom would end in a slump. That did occur from November 1948 to October 1949.

The US government stepped in after 1948 to provide macroeconomic stability, as Hansen said it would. Truman’s budget surplus of 4.6% of GDP in fiscal year 1948 fell to 0.2% in fiscal year 1949, as spending went from $29.8 billion in 1948 to $38.8 billion in 1949, as automatic stabilizers kicked in. In fiscal year 1950 (July 1, 1949 to June 30 1950), the budget went into an actual deficit of 1.1% of GDP. Moreover, Congress had pushed through a tax cut in 1948, which boosted private spending in 1949.

What we have here is classic Keynesian countercyclical fiscal policy. Some of the increases from 1950–1953 were, of course, related to the Korean war, but also to new social, welfare and military programs enacted under Truman. Government spending in both absolute terms and as a percentage of GDP surged from 1948 to 1953, fell slightly from 1953–1954 as the Korean war ended, but remained between about 25% and 30% of GDP throughout the classic era of Keynesian economics (1945–1973) – an unprecedented level to that point in American history. And the economy boomed.

In 1943, Keynes was giving a lecture at the Federal Reserve and was asked by Abba Lerner about the possible economic problems of the post-war period. Keynes also predicted a post war boom:

“Keynes harshly rejected the risk of post-war stagnation, holding that because of Social security there would be a large reduction in private saving and so that would be no problem.” (Colander and Landreth 1996: 202).

But it is no surprise that the opinions of Keynes himself, Hansen and also Richard M. Bissell (actually cited in Samuelson 1943: 53, n. 1) are airbrushed out of the grossly distorted Austrian view of this period.